Responsibility centers

MCS

MCS

CENTARLISATION
&
DECENTRALISATION

Why should we have decentralised

system?(1/1)
Quality of decision making improves
Speed of decision making improves
H.Q. is relieved of day to day decision
making
Managers at decentralised units get
exposure to decision making in functional
areas and the managers at H.Q. get exposure
in evaluation and supervision areas
Managers at decentralised units become
more aware of the differences in personal
goals and the organisation goals.

Why should we not have

decentralised system?(1/2)
Top management has to rely on the
management control reports
H.Q. managers are more capable or better
informed and therefore can take better
quality decisions
Frictions arise on the issues like transfer
price, overhead charges and the credit
for the success
The decentralised units instead of
cooperating start competing with each
other

Why should we not have

decentralised system?(2/2)
Decentralisation may impose
additional costs because of
additional management, staff,
record keeping etc.
Competent persons to head the
decentralised units may not be
available
Emphasis is placed on short run
achievements rather than long
run goals

Delegation (1/1)
Delegation without authority is of no
consequence.
It is like tying the hands and feet of a
person and asking him to run.
Delegation of the powers to the manager
of the decentralised unit is the soul of
decentralisation.
Authority must be delegated
commensurate to the activities / goals and
the capability of the manager in charge.

Efficiency and
Effectiveness(1/2)
These are the measures of the performance

Efficiency:
It is a comparative, rather than absolute
measure of performance
we say that one is more efficient than the
other or one is more efficient now than in
the past or one is more efficient than the
standards/ideal etc.
It is mostly quantitative measure between
the input and the output

Efficiency and
Effectiveness(2/2)
Effectiveness:
It is a measure of the contribution of the
one to the overall objective of the whole
Since the objectives of the whole and
the contribution to the objectives are
both difficult to quantify , this measure is
mostly qualitative

Epitome:
In other words one is efficient if one does
the things right, and one is effective if one
does the right things.

Responsibility Centers
Definition:
A responsibility center is an
organisation unit that is
headed by a manager who is
responsible for its actvities.

Types of Responsibility
Centers
1. Revenue Centers
2. Expense Centers
i. Engineered Expense Center
ii. Discretionary Expense Center

3. Profit Centers
4. Investment Centers

Revenue Centers(1/3)

In a revenue center, output (i.e.

revenue is measured in
monetary terms, but no formal
attempt is made to relate input
(i.e. expense or cost) to output.

Efficiency of the Revenue

Centers(2/3)
Efficiency of these centers is
measured against the budgets or
quotas.
Managers are held responsible
for the direct expenses incurred
in the center.
They are however not charged
with the cost of the goods they
market or sell.
Primary efficiency measurement

Revenue Centers(3/3)
Inputs are not related to outputs

Inputs (only
for costs
directly
incurred)

work

Outputs in
monetary
terms

Examples: Marketing, Sales and Distribution,

Counselors in academic or financial products etc.

Expense centers(1/7)
Expense centers are responsibility
centers whose inputs are measured in
monetary terms, but whose outputs
are not.
There are two types of the expense
centers:
Engineered Expenses Center:
These are those centers for which the
costs can ascertained with precision. For
example, raw material cost, wages,
power, fuel etc.

Discretionary Expenses Center:

Engineered Expense
Centers (2/7)
Engineered Expense have the
following charecteristics:
Their inputs can be measured in
monetary terms.
Their output can be measured in
physical terms.
Optimum cost incurred per unit of
output can be determined
The following are the examples:
manufacturing operations, warehousing,
distribution, trucking etc.

Efficiency of the EEC

(3/7)

Standard cost is calculated from the

historical data or the standards already
set.
Actual cost is calculated.
These costs are then compared and the
efficiency or otherwise is determined.
Besides this managers are responsible for
the activities such as training, employee
development, that are not related to the
current production
The
overhead
costs
are
however
determined by the HQ.

Engineered Expense
Centers (4/7)
Optimal relationship
Can be established
Inputs in monetary terms

Outputs in physical terms

work

Example: factory expenses, manufacturing expenses,

Discretionary Expense Center

(5/7)
These type of centers include the
following activities:
Administrative unit
Support unit
Legal services
Industrial relations and human resources
Public relations
Research and development
Marketing and advertisement

Efficiency of the DEC (6/7)

Difference between the budgeted
and the actual expense is NOT the
efficiency measure for DEC.
it is difficult to assess the efficiency
of these centers.

Discretionary Expense Centers

(7/7)

Optimal relationship cannot

be established
Inputs in monetary terms

work

Output in physical terms

Examples: Research and Development

department, Advertisements etc.

Profit Centers (1/11)

When the responsibility centers financial
performance is measured in terms of profit (i.e.
difference between the revenues and the
expenses), the center is called as Profit Center.
All SBUs are profit centers but all profit centers
are not SBUs.
All organisations take step in creating the profit
centers at the lowest point in an organisation
where the following two conditions are met.
The manager should have access to the relevant
information needed for making such a decision.
There should be some way to measure the
effectiveness of the trade-offs the manager has
made.

Business Unit
or
Strategic Business Unit (SBU)
(2/11)
Companies create business units
because they have decided to
delegate more authority to the
operating managers.
Degree of delegation may differ
from company to company
However the complete authority
for generating profit is never
delegated to a single segment of

Advantages of Profit
Centers(3/11)
Quality of decision making improves as
they are nearest to the point of decision
making.
Speed of decision making is increased
because the instructions are not sought
from the HQ.
HQ is relieved of the day to day decision
making for the petty issues involving the
profit centers.
Managers are freer to use their
imagination and the initiative.

Advantages of Profit
Centers(4/11)
As the profit centers are similar to the
independent companies, they provide an
excellent training ground for general
management. Their management gain
experience in managing all functional
areas, and the upper management gains
the opportunity to evaluate their potential
for higher level jobs
Profit consciousness is enhanced since the
managers who are responsible for profits
will constantly seek ways to enhance them.

Advantages of Profit
Centers(5/11)
Profit centers provide top
management with ready made
information on the profitability
of the companys individual
components.
Because their output is so
readily measured, profit centers
are particularly responsive to
pressures to improve their
competitive performance.

Difficulties with Profit

Centers(6/11)
Decentralised decision making will
force top management to rely on
management control reports than on
personal knowledge of an operation,
entailing some loss of control.
If HQ management is more capable
or more informed than the profit
center manager, the quality of the
decision makingat unit level may be
reduced.

Difficulties with Profit

Centers(7/11)
Friction may increase because of
arguments over the appropriate transfer
price, the assignment of the common
costs, and the credit for the revenues that
were formerly generated jointly by two or
more business units working together.
Organisation units that once cooperated
with each other as functional units may
now be in competition with each other.

Difficulties with Profit

Centers(8/11)
Decentralisation may impose
additional costs because of
additional management, staff and
record keeping required, and may
lead to task redundancies at each
profit center.
Competent managers may not exist
in a functional organisation because
there may not have been sufficient
opportunities for them to develop

Difficulties with Profit Centers

(9/11)
There may be too much emphasis on
short run profitability at the expense of
long run profitability. In the desire to
report high current profits, the profit
center manager may skimp on R & D,
Training programe or maintainence
There is no completely satisfactory system
of ensuring that optimising the profits of
each individual profit center will optimise
the profit of the company as a whole.

Measuring the efficiency of the

Profit Centers(10/11)
1. Contribution margin (spread between
revenue and variable expenses)
2. Direct profit (profit centers contribution
to the general overhead or the profit of
the company)
3. Controllable profit (non controllable
expenses of the HQ are subtracted from
the total expenses while calculating profit)
4. Income before tax (PBT)
5. Net income (PAT)

Profit Centers (11/11)

Inputs are related to outputs

Inputs in monetary terms

work

Outputs are in monetary terms

These are business units (with some modifications or

amendments functional units can be converted as
business units)

Investment centers (1/5)

This is a special type of profit center
In such type of centers profit is compared to
the assets employed to earn it.
The sum of assets employed in the investment
center is called as investment base.
Profit is related to this investment base in the
following two ways:
The percentage of return on investment referred to
as ROI
Economic Value Added (EVA) also known as residual
income.

ROI and EVA (2/5)

ROI, Return on Investment is a ratio, the
numerator of which is income as reported in
the income statement and the denominator is
the assets employed.
Assets employed are total assets less current
liability which corresponds to shareholders
equity plus the non current liability.
EVA on the other hand (not being a ratio) is the
quantity in monetary terms. It is found by
subtracting a capital charge from the net
operating profit

Measuring the Assets

(3/5)

Cash
Receivables
Inventories
Working capital in general
Property, Plant and Equipment
Acquisition of new equipment
Gross block value

Measuring the
assets(4/5)

Disposition of assets
Annuity depreciation
Other valuation methods for the assets
Leased assets
Idle assets
Intangible assets
Noncurrent liabilities
The capital charge

Investment Centers (5/5)

Profits are related to the
Capital employed
Inputs in monetary terms Capital Outputs in monetary terms
Employed

These are business units

Questions so far asked by the

university on this topic.
1. What is responsibility center? List and
explain different types of responsibility
centers with sketches.
2. Every SBU is a profit center but every profit
center is not SBU? What are the conditions
that must be fulfilled for an organisation
unit to be converted into a profit center?
What are different ways to measure the
performance of a profit center? discuss
their relative merits and demerits.

Questions so far asked by the

university on this topic.
3. Briefly describe Engineered Expense
Centers and Discretionary Expense
Centers. How is budget prepared in each
and how is performance evaluated in
each?
4. What is a Strategic Business Unit? What
are the conditions required for creating
SBU? How is performance of SBU
measured? What are the advantages and
disadvantages of creating SBUs?

Questions so far asked by the

university on this topic.
5. How is investment center different from
a profit center? What are the different
methods of judging their performance?
Which is better method?
6. Briefly describe Responsibility center,
engineered Expense center, Discretionary
Expense Center, Revenue Center, Profit
center. How is the performance of the
head of these centers evaluated?

Questions so far asked by the

university on this topic.
7. Every SBU is a profit center but every
profit center may not be SBU. Explain.
Under what conditions Production,
Marketing and Service Departments are
converted into profit centers?
8. What do you understand by Investment
Center? Explain two different methods by
which the performance of these centers
are measured? Also discuss their relative
merits and demerits.